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Bhaskar Chakravorti Headshot

We Have Lost Sight of the Real Ticking Bomb on the Korean Peninsula

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Thanks to the antics of Kim Jong-un, the Korean peninsula is hot yet again. North Korea's nuclear technology is closer to being able to strike the U.S. according to a new Pentagon report submitted to Congress last week. I do think we should take this threat seriously; however, as officials from the U.S., South Korea, China, among others, scramble to defuse the most immediate crisis, we are at risk of losing sight of the deeper, longer-term danger to the region. The crisis that has receded to the background is an economic one -- and we should not ignore it.

Now we all know that South Korea has been quite the rock star of emerging markets. It is one of the rare examples of countries that emerged from war, poverty and the inevitable "middle-income trap." It multiplied its GDP three-fold in just 20 years. It was the first nation that went from being an OECD aid recipient to joining the OECD donor committee. Today, Korean brands lead not only in "hidden" products such as LCD technology and memory chips, they are also integral to the global cultural zeitgeist: smartly designed Samsung smartphones give Apple a run for its money and K-pop star, PSY, is the monster hit of YouTube.

But, South Korea's charmed decades may end soon. It is possible that its future may resemble that of its neighbor, Japan, and its "lost decades." This, to my mind, is the real crisis on the peninsula. The current escalation of tensions with North Korea masks the real crisis and even contributes to deepening it. Most importantly, it takes leadership attention and focus off of the real crisis.

Like Japan, South Korea has a population that is aging rapidly. South Korean women had fertility rates of 1.21 between 2005 and 2010, one of the lowest in the world. An aging society has proven to be among Japan's most profound challenges; for South Korea the aging challenge promises to be even more acute.

For now, the problems of an aging society has not yet hit home in South Korea. A key reason is that there is a high rate of unemployment among South Korean college graduates. There is intense pressure for young Koreans to get into the most competitive schools; 82 percent of high-schoolers go to university, which means that there are a lot of qualified graduates looking for jobs. At the other end, the large businesses have not been able to provide enough jobs for over-qualified university trained graduates.

The pressures on unemployed graduates can trigger a giant economic crisis for South Korea even before it hits its demographic wall. In particular, I worry about the contributions of such pressures to three crucial risk factors: high indebtedness, an under-developed services sector and persistent social inequities. Consider each, in turn.

Many of the college graduates end up self-employed and have to take on additional debt on top of what their families have taken on to finance their education. Added to this is the fact that the median price for a home in South Korea -- at 7.7 times the median annual income -- is more than twice the U.S. multiple. South Korean household debt was 164 percent of disposable income in 2011, compared to 138 percent in the U.S. at the start of the housing crisis, according to Royal Bank of Scotland Group.

South Korea may have grown beyond middle income status, but for its growth to sustain it will need a large and productive services sector. As it stands, South Korea's economy is too heavily reliant on manufacturing. Its services sector is only 58 percent of the economy, compared with 80 percent in the United States or 73 percent in Japan. Moreover, this sector is unproductive. According to the OECD, South Korea's private-sector services productivity is only 56 percent of manufacturing productivity, in stark contrast to other developed nations where the two are on par with each other. The addition of over-qualified college graduates as reluctant services entrepreneurs only adds to the productivity problem since their presence contributes to the fragmented nature of the sector.

At the other end of the spectrum, Korea's famous business conglomerates, the chaebols, still garner the lion's share of preferential access to capital, opportunities and other resources. Because they constitute the country's elite, their dominance exacerbates social inequity. College graduates compete for the limited number of jobs with these conglomerates and when they cannot get them, as outsiders they operate with a severe disadvantage. As a result, the entrepreneurial class is not strong and the middle class continues to shrink.

In addition to these longer-term risks, the country faces many near-term difficulties. Half of its GDP is exports dependent. With the slowdown in Europe and in the major emerging markets, this is a drag on the economy. With quantitative easing in Japan, and devaluation of the yen, Japanese products will be more price competitive in the exports markets relative to those from Korea.

Of course, the crisis with North Korea creates its own drag in three major ways. One is that the uncertainty spooks investors away from South Korea and scares away companies as well (General Motors is already considering hedging their bets and establishing manufacturing elsewhere in Asia). Second, a geopolitical crisis, can take the Korea's new president Park Geun-hye's focus away from fixing the economy and instituting a process for reform of the chaebols and helping re-build the middle class - her "economic democracy" agenda. Third, getting drawn into a conflict with North Korea, puts South Korea on the wrong side of a political alliance vis-a-vis its most important market: China.

Over the longer term, a continuation of the conflict has a fourth negative impact: one of the most powerful economic arguments for unification of the Koreas would be a solution to the forthcoming demographic crisis; North Korea would add to the labor force when the inevitable demographic constraint becomes a real bind.

There is, indeed, a bomb waiting to go off on the Korean Peninsula, but it is not of the Kim Jong-un's making. Seoul and its allies in the U.S. and elsewhere must stop getting completely consumed by each round of the crisis with Pyongyang, and give equal -- if not greater emphasis -- to the very real and complex crisis that might cause the Korean economic miracle to implode. If that happens, it would give an unfortunate new meaning to "K-pop."

Bhaskar Chakravorti is Senior Associate Dean of International Business and Finance and Founding Executive Director of the Institute for Business in the Global Context at The Fletcher School of Law and Diplomacy at Tufts University He is the author of the book, The Slow Pace of Fast Change.